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What David Gardner Learned From His First Foray Into Penny Stocks

In this segment of theRule Breaker Investingpodcast, Motley Fool co-founder David Gardner goes back to the very beginning of his investing days, when he was just a college student.At that time, a story in The Wall Street Journal turned him on to a little company in the robotics field, whose stock was going for less than a buck a share.

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As he notes, there can be something alluring about a stock you can buy that cheap -- it has so much room to rise, after all. But if a companytrades for pennies, there's one important question you should ask about it before you buy.

A transcript follows the video.

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David Gardner: Investment number two. Now, this was not my second investment. This did not come right after Leaseway Transportation. The truth is I don't really remember what I bought next, and I had started with a portfolio already built for me. I'm not reviewing the very first six chronologically here. I'm reviewing six early ones that had a lesson attached to them.

So the second one I want to talk about is a company called Interlab Robotics, and if you actually recognized the name of Leaseway Transportation earlier, good for you. I just bet that no one has ever heard of Interlab Robotics. So this was my first foray, and really my only foray, into penny stocks.

I had just read an article in The Wall Street Journal that a company called Interlab Robotics -- and because I've always been future oriented and robotics sounded exciting to me at the age of 18 or 19 -- that this company in The Wall Street Journal was reported to have a $40 million contract with China for its robotics. At the time, I didn't really know what the robots were. I didn't know how hard it was going to be to do business with China.

What I did know is that it was trading at $15/32. Now, I'm betraying my age by giving you a fraction, because for those of you who are dyed-in-the-wool longtime investors, you'll remember that stocks used to trade in fractions. That's the way it was for a long, long time, until only about 20 or so years ago.

So Interlab Robotics was at less than $0.50 a share -- 15/32 -- and the good news here for me -- because the bad news is about to come in this story -- but the good news is I put almost nothing at risk. I thought, "This is going to be fun. This is silly. The story is plausible. It sounds potentially exciting. Gee, if this stock just goes from 15/32 to, I don't know, 32/32, or one dollar a share, I will more than double my money." It sounded really exciting. It always does to anybody who's picking through penny stocks. And as it turns out, history will show that Interlab Robotics crested briefly to 19/32, at which point it fell to 0/32 over the subsequent, I'm going to say, year or so with my money riding on it.

So I think the reason I want to tell this story is because it's natural. There's a natural allure to very low-priced stocks, especially for new investors, and I guess to my credit I was self-consciously acknowledging that, and just having fun with it, and just putting very little of my portfolio at stake -- well less than 1% of the portfolio in Interlab Robotics, and I was having fun speculating. And I guess, in retrospect, it's good that it didn't play out really well for me, because I might have started to believe that these kinds of investments are for real.

But the truth is, throughout my life I've been reminded, more often than not, that if something trades for pennies, the biggest question is not, "Hey, could I double my money if it makes it to a dollar a share?" The biggest question to ask yourself is, "How did it ever get to such a low share price in the first place?" And usually there are a number of key factors there which continue to play out and make penny stocks one of the worst offers every day on our modern stock market.

I realize there are some penny stock aficionados listening, and I realize some people have had a big hit here or there, but in terms of really being a significant part of betting your financial future, I wouldn't bet at all -- and it really is betting, I think, when you're playing that game. So Interlab Robotics, you're gone today, but I thank you for the lessons.